As an up and coming financial analysist in the specialist corporate advisory firm High End Strategy Ltd, the Managing Partner has asked you to prepare briefing notes for a forthcoming meeting with a new client. This client is Higher Health Precision Tools Pty Ltd is (HHTP) and is currently a small engineering company that has an emerging reputation as a specialist tooling provider for health equipment manufacturers.

HHTP was started 7 years ago by its managing director Hiro Suzuki and is set up as private limited liability corporation. HHTPs latest audited income statement and balance sheet are attached, along with forecasts for the current year. HHTP has 4 directors. The directors include Hiro who also acts as Chairman, and who provided the original patents and ideas that established the business, and three non-executive directors who provided the initial equity capital (33% each)). The four directors hold equal shares in the company (Hiro received his shares based on providing the patents). The company employs around 28 people 25 in the production processes and 3 managers (including Hiro as Managing Director, a Production Manager and a Finance Manager). They lease a small but high quality facility in western Tokyo (a building of 1,450 square metres).

With the expected expansion of health demand in the coming decades, HHTP had a recent strategic planning retreat in which the senior management team has discussed becoming more aggressive to take advantage of new activities they see developing in the coming years. Hiro has had discussions with a number of different health technology firms about providing the tooling product for their operations and they have been very positive.

Hiro-san has proposed that the company has significant opportunities becoming available which can lead to a significant expansion of operations (but will also require a significant increase in operations capability). While individual projects will be assessed as they come about, he believes that some fundamental preparatory steps need to be undertaken now. These steps would set the framework to be able to respond to the opportunities as they evolve.

Specifically, Hiro-san believes that:

The company will have the opportunity to pick up an additional 3 or 4 projects a year, averaging between 70 and 100 million in turnover per project.

Should HHTP proceed with the projects, it will need a substantial increase in investment capital to fund new equipment, and an increase in building space (the current 1,450 square metres will be insufficient). In terms of plant and equipment they need to double or even triple the current machinery levels

Given the growth in the health industry, and in the value inherent in the companies patented processes and products, there will be even more opportunities into the future

Case Study 1: BBT Managerial Finance 181 P a g e | 1

Hiro-san has done some preliminary work on alternative properties and has identified 2 preliminary options:

The current leasing agent (i.e. who manages their current property) has identified a slightly newer and bigger property (4,200 sm building area) with better access to the subway and a little closer to the facilities of some of the most likely customers (which will reduce transport costs). The initial leasing cost cited was annually 29.56 million for a 3 year lease, to be paid monthly in advance. There would be little to be done in terms of property adaptation, it would simply be a matter of moving the equipment in and setting up the work spaces. A 5 year lease would most likely be discounted to a lower rate of 28.7 million annually.

A similar property of 4,500 sm (building area) is available for purchase at 640 million. It would need a further 150 million spent on it to make it suitable (it would need substantial work to fit it out for HHTPs operations, and is a little old and run down). You have rung some contacts of your in some banks and initial discussions have suggested you could finance an 70% mortgage (of the purchase price and the improvements) with a 25 year loan (paid monthly) and an interest rate of 2.1% per annum

2 of the non-executive directors are quite supportive of the plans. However the third is talking about wanting to withdraw his equity share out of the business (he wants to retire and move down to Atami and needs his funds to buy his retirement policy). He has flagged that he would like to be bought out and has proposed that he would like a 40% premium on 25% of the current book value of equity based on an argument that the book value under-represents the market value of the company, especially in light of the opportunities. The two directors in favour are not keen on putting in more equity, but a private equity firm has been nosing around with some expressions of interest.

Hiro-san is (privately) also interested in stepping down as Managing Director (while remaining chair of the board) so that he can devote more time to another business idea he has in consumer based technology products. He has been grooming the companys finance manager to take over as Managing Director, but is concerned that while the finance manager has solid management skills, he does not have sufficient expertise not networks for discussing the needs of potential clients.

One of the supportive Directors has expressed some concerns about expanding when the companys current profitability is so poor, while another has complemented the Managing Director on the fantastic expected outcome in 2017 and said that it bodes well for the new projects.

Hiro-san has never looked at fixed income securities market for his personal investments, but given the riskiness of his new business venture a friend has suggested he should invest in real estate investment trusts (which are issued by investment companies and operate the same as standard corporate bonds but are secured by real estate projects). His friend has has suggested that REITs offer good returns, but are secure as they are backed by the physical property and that the funds perform countercyclically to stock markets (most of Hiro-sans investments are in equities). His friend has identified two bonds issues that he has recommends

o REITAcurrentlysellingonthemarketatUS$1,024with25yearstomaturity,anda coupon rate of 6.3% (paid semi-annually). The fund focusses on commercial property in the southern states of the USA.

o REIT B currently selling on the market for US$963 with 20 years to maturity and a coupon rate of 5.3% (paid semi-annually). This fund focuses on real estate projects in India and Bangladesh.

With this as context, your managing partner has asked you to prepare him a briefing for his upcoming meeting with Hiro-san, that addresses the following specific issues:

1. Provide recommendations with respect to the buy-out request from the Director who wants to withdraw from the business (is his request fair, or what alternative would be more appropriate)

2. The direct financial ramifications of the leasing versus the buying (and borrowing) decision for accessing a larger premises along with pragmatic and strategic considerations (the advantages and disadvantages of owning rather than leasing).

3. Hiro-san is particularly concerned that the current low interest rate environment will not be sustained in the longer term and wants to know, if HHTP buys the property, how much more per month will need to be paid if interest rates increase by 1% or 2% in 2 years time or in 5 years time. You should also comment on the likelihood of that occurring given current interest rate trends in Japan.

4. Whether debt funding would be desirable, or even possible for the new equipment required should the company decide to pursue aggressive expansion noting that the equipment used by the business is quite specialised and cannot easily be sold and taken to another company.

5. Given the proposed expansion, that the current directors are not keen on putting in more capital should the company consider new private equity or even perhaps listing on the stock exchange.

6. Should Hiro step back as managing director, what changes might be recommend for governance of the firm, including recommendations as to an appropriate plan for remuneration and reporting for the new Managing Director.

7. Advice as to whether bonds in REIT A and/or REIT B represent a desirable product to add to Hiro-sans personal investment portfolio.

8. Review the financial statements of HHTP for the last two years, and confirm which of the alternative views amongst the Directors about profitability is correct, and why this might be correctNote that at this stage, the briefing paper does not need to recommend as to whether expansion is a good decision or not. It only requires addressing the above specific issues. Your company has asked Hiro-san for some more information on the clients and projects that might be possible before advice is provided in that context.8.

HHTP - Balance Sheet June 30th 2018 (forecast) ( million) June 30th 2017 million) actual Assets Current assets Cash and short term assets Accounts receivable 7.16 15.28 22.44 3.76 23.41 2717 Total Non-current assets Net plant and equipment 17.52 16.46 TOTAL ASSETS 39.96 43.63 Liabilities and equity (S'000s) Current liabilities Accounts payable Overdraft 5.81 1.29 7.10 11.55 1.29 12.84 Total Current Liabilities Non-current liabilities Long-term debt (loans on equipment) Total Non-Current Liabilities 7.06 6.10 7.06 6.10 Shareholders' equity Ordinary shares Retained earnings 22.68 3.13 25.81 39.96 22.68 2.01 24.69 43.63 Total Equity TOTAL LIABILITIES AND EQUITY